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The efficient market hypothesis: problems with interpretations of empirical tests

Author

Listed:
  • Denis Alajbeg

    (Zagreb School of Economics and Management, Zagreb)

  • Zoran Bubas

    (Zagreb School of Economics and Management, Zagreb)

  • Velimir Sonje

    (Zagreb School of Economics and Management, Zagreb)

Abstract

Despite many “refutations” in empirical tests, the efficient market hypothesis (EMH) remains the central concept of financial economics. The EMH’s resistance to the results of empirical testing emerges from the fact that the EMH is not a falsifiable theory. Its axiomatic definition shows how asset prices would behave under assumed conditions. Testing for this price behavior does not make much sense as the conditions in the financial markets are much more complex than the simplified conditions of perfect competition, zero transaction costs and free information used in the formulation of the EMH. Some recent developments within the tradition of the adaptive market hypothesis are promising regarding development of a falsifiable theory of price formation in financial markets, but are far from giving assurance that we are approaching a new formulation. The most that can be done in the meantime is to be very cautious while interpreting the empirical evidence that is presented as “testing” the EMH.

Suggested Citation

  • Denis Alajbeg & Zoran Bubas & Velimir Sonje, 2012. "The efficient market hypothesis: problems with interpretations of empirical tests," Financial Theory and Practice, Institute of Public Finance, vol. 36(1), pages 53-72.
  • Handle: RePEc:ipf:finteo:v:36:y:2012:i:1:p:53-72
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